Should You Lease a Home With an Option to Buy?

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Published September 21, 2012

| Bankrate.com

Despite the losses that have stung so many, owning a home is still part of the American dream. But many families are blocked from buying because of poor credit, lack of a down payment or other financial concerns.

The desire to own someday but the need to rent now is "without question prompting an increased interest in rent-with-option-to-buy," says David Berenbaum, chief program officer for the National Community Reinvestment Coalition.

The contracts, known as either lease-option-to-buy or rent-option-to-buy, require renters to pay a fee for the option to buy at a specified price at a later date, often two or three years later. Often, the option fee is set aside toward the down payment for the purchase, explains Dean Alterman, a Portland, Ore., attorney and chair of the design and construction committee of the American Bar Association's real property section.

These lease-option-to-buy arrangements could prove financially beneficial for some, Berenbaum says. "Given that there are lots of affordable values in homes right now, these (contracts) could let a family find a home in the school district they want, with plans to buy at a relatively low price."

But he warns that the buyer should beware. "Anyone who enters into one of these contracts really needs to think about quite a few issues."

Here are three questions to ask before signing a lease-option-to-buy contract for a home.

Will you Qualify for a Mortgage Later?

"If you can't buy now, you have to honestly ask yourself, 'What's really going to change in the next couple of years?'" says Chris Kukla, senior counsel for governmental affairs at the Center for Responsible Lending, a Durham, N.C.-based nonprofit. Many people might not be able to rehabilitate their credit to qualify for a mortgage at the end of the option period, he warns.

With a lease-option-to-buy contract, another potential pitfall occurs when the option fee is added to the monthly rent so the accumulated money can be used as the down payment. The base rent must be the fair-market rent, and the option fee has to be over and above that. Otherwise, the lender might not approve a mortgage later.

For example, the rent is $900 and a $300 option fee is added to that. At the end of the two-year option, the renter plans to use the accumulated option fee ($300 multiplied by 24 months, or $7,200) as a down payment for the purchase.

"A lender will not accept that as a down payment if he thinks the fair market rent would be $1,200, not $900," Alterman says.

Before entering into one of these lease-option-to-buy agreements, Alterman suggests that consumers ask a mortgage lender to assess the likelihood of getting a mortgage later. And Kukla suggests seeing a housing counselor for advice on rehabilitating credit.

Is the Cost Worth It?

"The option fee compensates the owner of the home for taking the home off the market and for fixing a sale price," Alterman says. "Most contracts don't allow the owner to accept another offer during the option period."

It's typical for the fee to total anywhere from 3% to 5% of the purchase price, says Martin Orefice, founder of USLeaseOption.com, one of the many websites containing lease-option-to-buy listings.

Renters who don't purchase at the end of the period could lose the option fee. "I have never seen an option contract which refunds the fee," Alterman says.

Moreover, because lease-with-option-to-buy contracts are more common in markets where sales are sluggish, the value of the home may not rise during the option term, notes Donald Haurin, economics professor emeritus at The Ohio State University.

Renters should consult real estate agents for help gauging price trends in the area, and whether the specified price seems realistic, Berenbaum advises.

And if home values do shoot up over a two- or three-year option period, the owner may not honor the lease-option-to-buy contract. "The renter would have to hire a lawyer to enforce the contract," Haurin says.

Are There Traps in the Fine Print?

So many potential pitfalls are associated with lease-with-option-to-buy contracts that consumers should always hire an experienced real estate attorney to review the terms, Kukla says.

Kukla acknowledges that lease-with-option-to-buy arrangements are attractive to people who don't have much in savings. These same consumers might be reluctant to hire attorneys. Alterman estimates a real estate attorney may charge anywhere from $500 to $1,500.

Still, "people don't realize that they don't have the protections associated with a regular home purchase with these contracts," Kukla says.

Among the many measures protecting buyers in traditional home purchases is a title search to make sure that the seller can convey legal ownership. "You need a title search with rent-to-own, too," Kukla says. "The owner may be underwater with mortgages and wouldn't be able to sell at the agreed price. Or, there could be other liens that would prevent the sale."

An experienced real estate attorney should run a title search and review all the terms of the contract. Contract language could be overly onerous for renters, says Kukla -- for instance, giving the owner of the property the right to void the deal if the renter is late on just one payment.

 

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